Should shares pledged to the issuing credit institution as collateral to secure a loan granted by the same credit institution to a customer be deducted from Common Equity Tier 1 items where, in case of default of the customer, the credit institution has the option to either appropriate the collateral or force its sale, bearing in mind that this does not affect the existence of a relationship between the value of the loan and the value of the shares?
The question arises as to whether the pledge of the shares would fulfil or not the requirements of Article 36(1)(f) of the CRR. It should be clarified whether the acceptance of shares as collateral to secure a loan (i) fulfils the definition of indirect or synthetic holding and/or (ii) meets the condition that the institution has an actual or contingent obligation to purchase by virtue of an existing contractual obligation.
The shares are not eligible in accordance with Article 28(1)(b) CRR and Article 8 and 9 of Delegated Regulation (EU) No 241/2014 (RTS on own funds), in case the loan is granted for the purpose of funding the acquisition of the shares (see EBA Q&A 2013_008). If the loan is not to be considered as an indirect or direct funding of the pledged shares, they should be deducted for the following reasons:
As clarified in EBA Q&A 2013_009, where criteria of the RTS on own funds are met and the operation qualifies as an indirect or synthetic holding, the value of the pledged own regulatory capital instruments will have to be deducted under Article 36(1)(f) of the CRR. The value of the capital instruments that will have to be deducted in that case is the accounting value of the instruments that are counted towards regulatory own funds.
The value of the bank’s investment (i.e., the loan) will depend on the collateral and this is regardless of the process followed for its realisation. Since pursuant to Article 4(1)(126) CRR ‘synthetic holding’ means an investment by an institution in a financial instrument the value of which is directly linked to the value of the capital instruments issued by a financial sector entity, pledged shares qualify as synthetic holdings given that the value of the loan would be linked to the value of the own capital instrument; this is because either the fair value of the loan which incorporates credit risk would depend on the recovery cash-flows from the pledged shares in the case of a potential future default or the loan loss provision (esp. under IFRS 9) , so there is a direct link that is relevant for own funds purposes. Because of the link between the value of the loan and the value of the pledged shares, the loan granted by the institution (together with the shares pledged as collateral) should be seen as a financial instrument the value of which is directly linked to the value of the (pledged) shares issued by the institution. Therefore granting such a loan should be seen as an investment by the institution in a financial instrument the value of which is directly linked to the value of the capital instruments issued by the institution and as such a ‘synthetic holding’ within the meaning of Article 4(126) CRR.
Moreover, Article 36(1)(f) CRR requires deduction for the following items: “direct, indirect and synthetic holdings by an institution of own Common Equity Tier 1 instruments, including own Common Equity Tier 1 instruments that an institution is under an actual or contingent obligation to purchase by virtue of an existing contractual obligation;”. In some legal systems, a contingent obligation to purchase may exist in case the debtor defaults (so when it does not comply with the existing contractual obligation to repay the loan) and the other methods for enforcing the collateral are not successful.
Aspects that are not part of the question raised cannot be considered in the answer, hence the answer is limited to the specific case of pledged own shares.